Liquidity and Capital Resources

 

Cash Flow Activities

 

Our cash balance decreased $14.8 million to $42.1 million at December 31, 2007 from $56.9 million at December 31, 2006.

 

Cash flows from operating activities were $42.3 million in 2007, an increase of $0.5 million when compared to $41.8 million in 2006. This increase is due to increased operating performance at DJW due to timing of the opening of the casino in April 2006 and the casino expansion in 2007, as well as an increase in operating performance at EVD, offset by a decrease in operating performance at DJL due to increased competition from the expansion of a local competitor in 2006 as well as the effects of adverse weather conditions in the fourth quarter of 2007 and an increase in general corporate payroll and operating expenses.

 

Cash flows used in investing activities during 2007 was $50.6 million consisting of cash outflows of (i) payments of approximately $34.4 million for construction and other development costs associated with various projects including the DJW casino expansion project, the DJL casino development project and the EVD hotel development project, (ii) cash outflows of $14.7 million for the purchase of the City Bonds by DJW, (iii) cash outflows of $6.5 million used for general maintenance capital expenditures at DJL, EVD and DJW, (iv) payments to long-term deposit of $6.4 million by DJL in accordance with the Development Agreement with the City of Dubuque, Iowa and (v) business acquisition and licensing costs of $1.5 million. These outflows were partially offset by proceeds from our restricted cash balance designated for construction and other development costs associated with the Worth County casino development and expansion project of $13.0 million.

 

Cash flows used in financing activities during 2007 of $6.6 million reflects the proceeds of $22.7 million from the offering of $23.0 million in additional DJW Notes, partially offset by (i) aggregate principal payments on debt of $13.7 million, including principal payments under the term loan portion of the PGL Credit Facility of $4.7 million, (ii) payment of deferred financing costs of $9.1 million primarily related to the discount associated with the purchase of the City Bonds by DJW with a corresponding non-cash contribution to DJL and (iii) member distributions of approximately $6.4 million.

 

Cash flows from operating activities were $41.8 million in 2006, an increase of $20.3 million when compared to $21.5 million in 2005. The increase is primarily due to the opening of the DJW casino as DJW had $21.0 million in cash flows from operating activities in 2006 compared to $(0.7) million in 2005.

Cash flows used in investing activities during 2006 was $32.0 million consisting of cash outflows of (i) payments of approximately $23.6 million for construction and other development costs associated with the Worth County casino development and expansion project, (ii) net cash outflows of approximately $12.7 million used for capital expenditures mainly related to the development of our new OTB in Eunice, Louisiana, the acquisition of slot machines and slot machine conversions and general maintenance capital expenditures at DJL, OED and DJW, (iii) business acquisition and licensing costs of $1.5 million and (iv) changes in cash surrender value of $0.3 million of key person life insurance policies. These outflows were partially offset by a decrease in our restricted cash balance designated for construction and other development costs associated with the Worth County casino development and expansion project of $6.1 million.

 

Cash flows from financing activities during 2006 of $34.3 million reflects (i) proceeds from the offering of $56.5 million in additional DJW Notes, (ii) net proceeds of $21.8 million from the offering of $22.0 million principal amount of additional Peninsula Gaming Notes, net of discount, and (iii) aggregate borrowings under the revolver portion of the PGL Credit Facility and under the DJW Credit Facility of $29.7 million. These inflows were partially offset by (i) aggregate principal payments under the revolver portion of the PGL Credit Facility and DJW Credit Facility of $53.5 million, (ii) payment of deferred financing costs associated with the issuance of the additional DJW Notes and Peninsula Gaming Notes of $4.4 million, (iii) redemption by DJL of preferred members interest — redeemable of $4.0 million, (iv) aggregate principal payments under the term loan portion of the PGL Credit Facility of $4.0 million, (v) aggregate principal payments on notes payable of $5.3 million and (vi) member distributions of approximately $2.5 million.

 

As of December 31, 2007, the Company had no outstanding balances under the revolver portion and the term loan portion of the PGL Credit Facility, and outstanding letters of credit of approximately $0.8 million. In addition, as of December 31, 2007, DJW had no outstanding balances under the DJW Credit Facility and outstanding letters of credit of approximately $0.7 million.

 

Financing Activities

 

On April 16, 2004, DJL and PGC completed a private placement of $233 million principal amount of 8 ¾% senior secured notes due 2012 (the “Peninsula Gaming Notes”). The Peninsula Gaming Notes were issued at a discount of approximately $3.3 million. Interest on the Peninsula Gaming Notes is payable semi-annually on April 15 and October 15 of each year, beginning on October 15, 2004. Upon a corporate restructuring, the Company also became a co-issuer of the Peninsula Gaming Notes.

 

On December 22, 2006, the Company, DJL, and PGC, as co-issuers, issued and sold to a third party investor in a private placement $22.0 million aggregate principal amount of Peninsula Gaming Notes (“Additional Peninsula Gaming Notes”).  The Company used a portion of the net proceeds from this issuance of the Additional Peninsula Gaming Notes to pay down borrowings under its existing senior credit facility and to finance, in part, the construction of the new casino at DJL and the development of the hotel at EVD.

 

The indenture governing the Peninsula Gaming Notes limits the Company’s ability to, among other things, incur more debt; pay dividends or make other distributions to PGP and DJW (for so long as DJW is an unrestricted subsidiary); redeem stock; make certain investments; create liens; enter into transactions with affiliates; merge or consolidate; and transfer or sell assets.

 

The Peninsula Gaming Notes are full and unconditional obligations of DJL as a co-issuer. PGL and PGC, also co-issuers, have no independent assets (other than PGL’s cash and investment in its subsidiaries) or operations. The Peninsula Gaming Notes are secured by substantially all the assets of PGL, DJL and EVD subject to the prior lien of the PGL Credit Facility as discussed below. The Peninsula Gaming Notes are also fully and unconditionally guaranteed, subject to the prior lien of the PGL Credit Facility, by EVD. Further, EVD and DJL have pledged their equity interests as collateral. All of DJL’s and EVD’s net assets are restricted except for $5.1 million at December 31, 2007 under the Peninsula Gaming Notes. The Peninsula Gaming Notes do not limit DJL’s or EVD’s ability to transfer net assets between PGL, DJL and EVD.

 

In July 2005, DJW completed a private placement of $40.0 million aggregate principal amount of DJW Notes. In connection with the offering of the DJW Notes, DJW was designated an “unrestricted subsidiary” by the Company under the indenture governing the Peninsula Gaming Notes, and DJW was released of its obligations under the PGL Credit Facility. The DJW Notes bear interest at a rate of 11% per year, payable semi-annually on April 15 and October 15 of each year.

 

The DJW Notes are secured by a pledge of the equity of DJW and DJWC and substantially all of DJW’s current and future assets. The lien on the collateral that secures the DJW Notes is contractually subordinated to the liens securing up to $5.0 million of indebtedness under the DJW Credit Facility as discussed below. The DJW Notes, which mature on April 15, 2012, are redeemable at the Company’s option, in whole or in part at any time or from time to time, on and after April 15, 2008 at certain specified redemption prices set forth in the indenture governing the DJW Notes. The indenture governing the DJW Notes contains a number of restrictive covenants and agreements, including covenants that limit the ability of the Company and its subsidiaries to, among other things: (1) pay dividends, redeem stock or make other distributions or restricted payments; (2) incur indebtedness or issue preferred shares; (3) make certain investments; (4) create liens; (5) consolidate or merge; (6) sell or otherwise transfer or dispose of assets; (7) enter into transactions with affiliates; (8) use proceeds of permitted asset sales and (9) change its line of business. Specifically, DJW is prohibited from making any dividends or other distributions to PGL, subject to certain limited exceptions. DJW is permitted to make dividends or other distributions to PGL to pay certain tax obligations. Further, DJW can make dividends and other distributions to PGL to pay corporate overhead or similar allocations or payments, including, but not limited to, tax preparation, accounting, licensure, legal and administrative fees and expenses. Additionally, DJW may make dividends and other distributions to PGL in respect of certain payments under management agreements and to pay reasonable directors’ or managers’ fees and expenses, so long as any payments with respect to any management agreement or certain employee, consulting or similar agreements do not, in the aggregate, in any fiscal year exceed (a) for 2006, $500,000, (b) for 2007, the product of 1.333333 multiplied by 4.0% of DJW’s Consolidated EBITDA (as defined in the indenture governing the DJW Notes) for the nine months ended December 31, 2006 and (c) for any fiscal year thereafter, 4.0% of DJW’s Consolidated EBITDA for the preceding fiscal year. Finally, DJW can make additional dividends and other distributions not to exceed $0.5 million. Subject to the foregoing provisions, all of the net assets of DJW are restricted.

 

On August 31, 2006, DJW entered into the First Supplemental Indenture to the Indenture dated as of July 19, 2005 (the “DJW First Supplemental Indenture”) which permitted, among other things, the issuance by DJW on August 31, 2006 of an additional $20 million principal amount of DJW Notes, the proceeds of which were used in part to fund the current expansion of the DJW casino. In addition, the DJW First Supplemental Indenture requires DJW to offer to buy back a portion of the DJW Notes on a semi-annual basis, beginning March 31, 2007, with 50% of Excess Cash Flow (as defined therein) at a premium of 7.5%. Such provision was determined to be an embedded derivative and was fair valued and separated from the DJW Notes at date of issuance since it was not clearly and closely related. As of December 31, 2007 and December 31, 2006, the fair value of the put option was approximately $1.3 million and $0.5 million, respectively. The fair value of the put option

was determined to be the present value of the estimated premium payments through the maturity of the DJW Notes. The estimated premium payments were calculated using estimated future cash flows developed by the Company to estimate the portion of the DJW Notes that would be subject to the contingent put option, yields of comparable financial instruments, the remaining date to maturity of the DJW Notes and based on discussions with the holders of the notes as to whether the contingent put option would be elected by the noteholders. The fair value of the put option is revalued at the end of each reporting period with a corresponding charge (benefit) to interest expense. During the year ended December 31, 2007, the Company expensed $0.9 million as interest expense related to the change in the fair value of the embedded derivative. In addition, DJW redeemed $2.4 million principal amount of DJW Notes in November 2007, plus the applicable premium and accrued interest, based on the Excess Cash Flow provision.

On December 21, 2006, DJW entered into the Second Supplemental Indenture to the Indenture dated as of July 19, 2005 (the “DJW Second Supplemental Indenture”) which permitted, among other things, the issuance by DJW on December 21, 2006 of an additional $36.5 million principal amount of DJW Notes (“Additional DJW Notes”) and the distribution of up to $35.0 million of the net proceeds of the Additional DJW Notes to PGL.  The distribution was made to PGL in 2006 and was used to pay down borrowings under its existing senior credit facility and to finance, in part, the current construction of the new casino at DJL and the development of the hotel at EVD.

 

On October 16, 2007, DJW entered into the Third Supplemental Indenture to the Indenture dated as of July 19, 2005 which permitted, among other things, the issuance by DJW on October 16, 2007 of an additional $23.0 million principal amount of DJW Notes at a purchase price of 98.5% of the principal amount thereof, the proceeds of which were used to fund the purchase of DJW’s investment in the City Bonds.

On June 16, 2004, DJL and EVD jointly entered into a loan and security agreement with Wells Fargo Foothill, Inc. as the arranger and agent which was later amended in November 2004, July 2005 and December 2006 (as amended, the “PGL Credit Facility”). The PGL Credit Facility consists of a revolving credit facility which permits DJL and EVD to request advances and letters of credit up to the lesser of the maximum revolver amount of $65.0 million (less amounts outstanding under letters of credit) and a specified borrowing base (the “Borrowing Base”). The Borrowing Base is the lesser of the combined EBITDA (as defined in the PGL Credit Facility) of EVD and DJL for the twelve months immediately preceding the current month end multiplied by 150% and the combined EBITDA of EVD and DJL for the most recent quarterly period annualized multiplied by 150%. At December 31, 2007, the maximum revolver amount was $65.0 million. The borrowings under the revolver portion of the PGL Credit Facility bear interest at a rate equal to the Wells Fargo prime rate plus a margin of 0.25%, or 7.5% at December 31, 2007. The available borrowing amount at December 31, 2007, after reductions for amounts borrowed and letters of credit outstanding at DJL and EVD, was $64.2 million. As of December 31, 2007, there were no outstanding advances under the revolver portion of the PGL Credit Facility and outstanding letters of credit of approximately $0.8 million.

 

The PGL Credit Facility also contained a term loan, the balance of which was paid off in November 2007.

 

DJL and EVD are jointly and severally liable under the PGL Credit Facility and such borrowings are collateralized by substantially all of the assets of EVD and DJL. Borrowings under the PGL Credit Facility are guaranteed by PGL and PGC.

 

The PGL Credit Facility contains a number of restrictive covenants, including covenants that limit DJL’s and EVD’s

 

ability to, among other things: (1) incur more debt; (2) create liens; (3) enter into any merger, consolidation, reorganization, or recapitalization, or reclassify its capital stock; (4) dispose of certain assets; (5) guarantee the debt of others; (6) pay dividends or make other distributions; (7) make investments; and (8) enter into transactions with affiliates. The PGL Credit Facility also contains financial covenants including a minimum combined EBITDA (as defined by the PGL Credit Facility) of DJL and EVD and limitations on capital expenditures at DJL and EVD.

 

Specifically, DJL and EVD are prohibited from making any dividends or other distributions to PGL or any of PGL’s unrestricted subsidiaries, subject to certain limited exceptions.  For example, DJL and EVD are permitted to make dividends or other distributions to PGL to pay certain tax obligations and to fund tax preparation, accounting, legal and administrative fees and expenses. Additionally, DJL and EVD may make dividends and other distributions to PGL in respect of certain payments under management agreements and to pay reasonable directors’ or managers’ fees and expenses, so long as such payments do not, in the aggregate, in any fiscal year exceed the lesser of (a) 4.0% of DJL and EVD’s combined EBITDA (as defined in the PGL Credit Facility) for the preceding fiscal year and (b) $4.0 million. DJL and EVD may also make dividends or other distributions to PGL so that PGL, subject to certain limitations, can repurchase, redeem or otherwise acquire equity interests in PGL or its restricted subsidiaries (as defined in the PGL Credit Facility) from its respective employees, members or managers.

 

During the third quarter of 2007, certain conditions precedent to the effectiveness of all remaining provisions (including the increase in available borrowings under the revolver portion of the facility to $65.0 million and the ability to make additional capital expenditures in connection with the proposed casino project at DJL) of the fourth amendment to the PGL Credit Facility were satisfied.

In July 2007, DJL, EVD and Wells Fargo Foothill, Inc., entered into a Consent to Loan and Security Agreement in which Wells Fargo Foothill, Inc. consented to capital expenditures by DJL, in addition to capital expenditures permitted by the original loan agreement and subsequent amendments, in an aggregate amount not to exceed $80.0 million for the DJL casino project.  DJL and EVD expect to enter into an amendment to the PGL Credit Facility in the second quarter of 2008 to allow for expected DJL casino project costs of $82.5 million.

On October 4, 2006, DJW and DJWC entered into a senior secured revolving credit facility with American Trust & Savings Bank that was subsequently amended on December 21, 2006 and October 16, 2007 (as amended, the “DJW Credit Facility”). The DJW Credit Facility permits DJW to request advances and letters of credit of up to $5.0 million. Advances under the DJW Credit Facility bear interest at a rate equal to the greater of (i) at DJW’s option, either LIBOR plus a margin 1.85%-2.20% or the Wall Street Journal prime rate less a margin of 1.0%, or 6.25% at December 31, 2007, and (ii) 5%. The DJW Credit Facility expires on March 1, 2010.  The available borrowing amount under such facility at December 31, 2007, after reductions for amounts borrowed and letters of credit outstanding at DJW, was $4.3 million. As of December 31, 2007, there were no outstanding advances under the DJW Credit Facility and outstanding letters of credit of approximately $0.7 million.

 

The DJW Credit Facility contains a number of restrictive covenants, including covenants that limit DJW’s ability to, among other things, incur or guarantee more debt and create liens. In addition, the DJW Credit Facility requires that, on an annual basis, DJW repay all advances (other than amounts designated under letters of credit) and such repayment of all advances must continue for a period of five days, after which, DJW will be allowed to resume requesting advances. The DJW Credit Facility also contains customary events of default, including nonpayment of principal and interest when due, violation

 

of covenants, material inaccuracy of representations and warranties, bankruptcy events, and material judgments. Certain of the events of default are subject to a grace period.

 

DJW’s and DJWC’s obligations under the DJW Credit Facility are secured by a security interest in substantially all of DJW’s and DJWC’s tangible and intangible assets. The DJW Credit Facility is secured by substantially the same assets that secure the DJW Notes. Pursuant to an intercreditor agreement between DJW and American Trust and Savings Bank, the lien on the collateral securing the DJW Credit Facility is contractually senior to the lien on the collateral securing the DJW Notes and the related guarantees. Our Chief Executive Officer agreed to unconditionally guarantee DJW’s payment obligations to the lender under the DJW Credit Facility.

 

     The Company was in compliance with all debt covenants as of December 31, 2007.

 

Liquidity

 

In addition to our cash on hand, we currently have the following sources of funds for our business: (i) cash flows from operations, (ii) available borrowings under the PGL Credit Facility and (iii) available borrowings under the DJW Credit Facility. The available borrowing amount at December 31, 2007, after reductions for amounts borrowed and letters of credit outstanding under the PGL Credit Facility and the DJW Credit Facility was $64.2 million and $4.3 million, respectively. Contractual restrictions and other provisions contained in the agreements governing our consolidated indebtedness, including our senior credit facilities and the indentures governing the Peninsula Gaming Notes and the DJW Notes, limit or restrict our ability to use the funds available to us at each of our gaming properties.

 

In September 2006, DJL announced its intent to develop and construct a new casino and entertainment complex near its current casino facility.  The development is currently under construction and is expected to include approximately 1,000 slot machines, 17 table games, a five-table poker room, various restaurants, a bowling center and an entertainment center.  The project is expected to cost approximately $82.5 million and is expected to open in the fall of 2008.

 

On October 1, 2007, DJL entered into the Development Agreement with the City regarding, among other things, the design, development, construction and financing of a public parking facility to be located adjacent to DJL’s proposed casino development. The total development cost of the parking facility is estimated to be approximately $23 million. In October 2007, the City entered into a guaranteed maximum price contract with a third party to construct the parking facility. As previously discussed, the City financed the expected construction costs through the issuance of the City Bonds purchased by DJW and an initial payment to the City by DJL of $6.4 million during 2007.  Based on this, we do not expect to make any further cash payments in respect to the public parking facility in 2008.

In addition, EVD is currently developing a 75,000 square foot 100 room hotel contiguous to its current casino.  Additional amenities for the hotel include a fitness center, meeting space, a full in-house support laundry and a guest business center. Adjoining the existing racino structure, the new hotel will provide easy access to the casino and all of EVD’s existing amenities.  EVD has engaged a local architect for the project and is currently in negotiations with developers for the approximately $15.0 million hotel.

For DJL and EVD, we expect our capital expenditures for the next twelve months, excluding any amounts related to the casino development at DJL and the hotel development at EVD, to be approximately $7.9 million. Capital expenditures for the next twelve months related to the casino development at DJL and the hotel development at EVD are expected to be approximately $69.3 million and $13.7 million, respectively. DJL and EVD’s debt maturities for the next twelve months are

 

expected to be approximately $0.6 million. DJL and EVD’s member distributions to PGP for the next twelve months are expected to be approximately $2.0 million.  The Company plans to finance these expected cash requirements with: (i) a portion of the available cash on hand at the Company, DJL and EVD of $28.3 million at December 31, 2007, excluding amounts needed for normal operations, (ii) cash generated from operations, (iii) available borrowings under the PGL Credit Facility and (iv) available vendor and equipment financing. There can be no assurances that such projects will be completed in the estimated time frames or at the estimated costs.  The PGL Credit Facility is scheduled to terminate in June 2008.  We are currently working with Wells Fargo Foothill, Inc., the arranger and agent under the current facility, to extend or renew the PGL Credit Facility under similar economic terms.  The Company expects to be able to extend or renew the PGL Credit Facility prior to its expiration.

 

For DJW, we expect our capital expenditures for the next twelve months to be approximately $3.5 million, including the $1.0 million payment due in May 2008 relatd to DJW’s gaming license. DJW’s debt maturities for the next twelve months are expected to be approximately $2.6 million. DJW’s member distributions to PGP for the next twelve months are expected to be approximately $0.7 million.  The Company plans to finance these expected cash requirements with: (i) a portion of the available cash on hand at DJW of $13.8 million at December 31, 2007, excluding amounts needed for normal operations and (ii) cash generated from operations.

 

Based on our cash on hand, expected cash flows from operations and our available sources of financing, we believe we will have adequate liquidity to satisfy our current operating needs at each of our gaming properties and to service our outstanding indebtedness for the next twelve months.

 

Our level of indebtedness will have several important effects on our future operations including, but not limited to, the following: (i) a significant portion of our cash flow from operations will be required to pay interest on our indebtedness and the indebtedness of our subsidiaries; (ii) the financial covenants contained in the agreements governing such indebtedness will require us and/or our subsidiaries to meet certain financial tests and may limit our respective abilities to borrow additional funds or to transfer or dispose of assets; (iii) our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired; and (iv) our ability to adapt to changes in the gaming or horse racing industries which affect the markets in which we operate could be limited.

 

(1)           Includes approximately $35.7 million related to DJL’s remaining minimum obligations to build the new casino under the Development Agreement, approximately $50.0 million related to DJL’s future obligations under the Minimum Assessment Agreement over a period of 30 years and approximately $3.6 million related to DJL’s obligation for capital expenditures under the Development Agreement over 30 years.

 

(2)           Included in other long-term liabilities is our unconditional obligation to contribute the dockside pavilion and Diamond Jo vessel of $5.5 million.  Such transfer is expected to occur in less than one year and will represent a noncash payment of our obligation under the Historical Society Agreement.  The obligation is classified as long-term because the related assets are still in use by DJL and included in property and equipment, net.

 

The following shows our contingent obligations at December 31, 2007 based on expiration dates (in millions):

 

 

Off-Balance Sheet Transactions

 

Other than as disclosed above, we do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, cash flows, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Recent Accounting Pronouncements

 

In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R significantly changes the way companies account for business combinations and will generally require more assets acquired and liabilities assumed to be measured at their acquisition-date fair value. Under SFAS 141R, legal fees and other transaction-related costs are expensed as incurred and are no longer included in goodwill as a cost of acquiring the business. SFAS 141R also requires, among other things, acquirers to estimate the acquisition-date fair value of any contingent consideration and to recognize any subsequent changes in the fair value of contingent consideration in earnings. In addition, restructuring costs the acquirer expected, but was not obligated, to incur will be recognized separately from the business acquisition. This accounting standard is effective for the Company’s year ending December 31, 2009. The Company is currently evaluating the impact of SFAS 141R on the Company’s financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure certain eligible financial assets and financial liabilities at fair value (the fair value option). SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. Unrealized gains and losses on items for which the fair value option is elected would be reported in earnings. SFAS 159 is effective for the Company's year ending December 31, 2008. The Company is currently evaluating whether to elect the fair

value option for eligible financial assets and/or financial liabilities and the impact, if any, of SFAS 159 on the Company’s financial statements.

 

In September 2006, the FASB issued SFAS   No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 indicates, among other things, a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. SFAS 157 is effective for the Company's year ending December 31, 2008, with the exception of certain non-financial assets and liabilities for which the effective date is the Company’s year ending December 31, 2009. The Company is currently evaluating the impact of SFAS 157 on the Company's financial statements.

 

Critical Accounting Policies

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We periodically evaluate our policies and the estimates and assumptions related to these policies.

Understanding our critical accounting policies and related risks is important in evaluating our financial condition and results of operations. The critical accounting policies used in preparation of the Company’s financial statements involve a significant use of management judgment on matters that are inherently uncertain and are described below. If actual results differ significantly from management’s estimates, there could be a material effect on our financial condition, results of operations and cash flows. Management regularly discusses the identification and development of these critical accounting policies with the Audit Committee of the Board of Managers. There have been no significant changes to the Company’s critical accounting policies during the year ended December 31, 2007.

 

Goodwill, Intangible and Other Long-Lived Assets.   We evaluate our goodwill, intangible and other long-lived assets for impairment on a periodic basis. For goodwill and intangible assets with indefinite lives, we compare the carrying values to fair values on an annual basis or sooner if an indication of impairment exists. Other long-lived assets are reviewed for impairment when management plans to dispose of assets or when events or circumstances indicate a possible impairment. For assets to be disposed of, we recognize the asset at the lower of carrying value or fair market value less costs of disposal, as estimated based on comparable asset sales, solicited offers, or a discounted cash flow model. For assets to be held and used, we review for impairment whenever indicators of impairment exist. We then compare the estimated future cash flows of the asset, on an undiscounted basis, to the carrying value of the asset. If the undiscounted cash flows exceed the carrying value, no impairment is indicated. If the undiscounted cash flows do not exceed the carrying value, then an impairment loss is recorded based on the fair value of the asset, typically measured using a discounted cash flow model. All recognized impairment losses, whether for assets to be disposed of or assets to be held and used, are recorded as operating expenses.

 

Our goodwill is related to our DJL operations. Our intangible assets consist of our tradename and our slot machine

 

and electronic video game and horse racing licenses related to our operations at EVD and our gaming license at DJW. We intend to use the EVD tradename for the foreseeable future and our EVD and DJW licenses are renewable subject to our compliance with state gaming and racing regulations and subject to voter approval of gaming in Worth County, Iowa every eight years. Our intangible assets, therefore, have been determined to have indefinite lives and are not amortized. Should these assets in the future be determined to have finite lives because of our decision to discontinue the use of the EVD tradename or our inability to renew our licenses at EVD or DJW, the intangible assets could become impaired and require an impairment charge and any unimpaired amounts would be amortized over their remaining useful lives.

 

There are several estimates, assumptions and decisions in measuring impairments of long-lived assets. First, management must determine the usage of the asset. To the extent management decides that an asset will be sold, it is more likely that an impairment may be recognized. Assets must be tested at the lowest level for which identifiable cash flows exist. This means that some assets must be grouped, and management has some discretion in the grouping of assets. Future cash flow estimates are, by their nature, subjective and actual results may differ materially from our estimates. Our estimates of cash flows are based on the current regulatory, social and economic climates, recent operating information and budgets of the various properties where we conduct operations. These estimates could be negatively impacted by changes in federal, state or local regulations, economic downturns, or other events affecting various forms of travel and access to our properties.

 

Goodwill and intangible assets are also subject to impairment by, among other factors, significant changes in gaming tax rates, competition and regulatory requirements; lack of license renewals; lack of voter reapproval in Iowa; and changes in the way we use our EVD tradename. At December 31, 2007, 2006 and 2005, we completed the annual impairment testing of all of our goodwill and intangible assets with indefinite lives and no impairments were indicated. We are required to perform an analysis of our goodwill and intangible assets at least on an annual basis. If our ongoing estimates of future cash flows are not met, we may have to record impairment charges in future accounting periods.

 

During the quarter ended June 30, 2006, management determined the undiscounted future cash flows of its Alexandria OTB did not support the recoverability of the fixed assets attributable to the OTB’s operation. As such, the Company recognized an impairment charge for the OTB’s assets that exceeded their estimated fair market value. The impairment charge of $0.4 million is included in depreciation and amortization in the consolidated statement of operations and is part of the Evangeline Downs operating segment.

 

         Investment Valuation .  Investment in the City Bonds were valued and recorded as $12.5 million at December 31, 2007.  The investment's fair value has been estimated by us in the absence of a readily determinable fair value.  Our estimate is based on current market rates and estimates of market conditions for instruments with similar terms, maturities, and degrees of risk.  As part of this process, we engaged two brokers to provide independent quotes for the investment.  The two broker quotes were materially consistent with each other.  A 10% change in the value of the investment at December 31, 2007 would change member's deficit by $1.2 million.

 

Equity Based Compensation.   Units granted by PGP to our employees under PGP’s Incentive Unit Plan contain a put option exercisable by the employee and are recorded at their estimated intrinsic value (which is the increase in the fair market value of the units granted based on a market multiple of forecasted total segment operating earnings) with a corresponding expense recorded within the statement of operations based on the percentage vested and any change in estimated intrinsic value at each reporting period. Fair market value of the units can change due to numerous factors including those previously mentioned under “Goodwill, Intangible and Other Long-Lived Assets”, and slower than anticipated increases or declines in operating revenues, unanticipated operating cost increases, construction delays, the market’s perception of the economy in general, the gaming industry, risk, interest rates, and alternative investments. Significant changes in estimates and forecasts related to the calculation of the estimated intrinsic value of the units may have a material effect on our results of operations in the period in which the revised estimate is made.

 

 

As of December 31, 2007, there was approximately $6.3 million of compensation expense related to nonvested awards which has not been recognized in the consolidated statement of operations.  Based on the estimated intrinsic value at

 

 

December 31, 2007, approximately $2.8 million of the unrecognized value of awards is scheduled to vest over the next nine months unless vested earlier per the terms of the awards.  The remaining $3.5 million is scheduled to vest upon a change in control of the Company.

 

 

A $1 change in the estimated intrinsic value of the units at December 31, 2007 would increase or decrease compensation expense by $0.1 million for the year ended December 31, 2007.

 

Litigation.   An estimated loss from a loss contingency is recorded when information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. Accounting for contingencies such as legal matters requires the use of judgment as to the probability of the outcome and the amount. Many legal contingencies can take years to be resolved. An adverse outcome could have a material impact on our financial condition, operating results and cash flows.